Compliance Blog

Earlier this summer, there was a NAFCU Compliance Monitor article on Check Fraud and Allocation of Loss under the Model UCC. It explained some of the basic concepts relevant to the UCC's allocation of loss rules for fraudulent and altered checks:

• Whether a check was properly payable (i.e., authorized by the member),
• The consequences of failing to meet the midnight deadline (i.e., failure to return the check by the midnight deadline makes the credit union accountable for the check), and
• Transfer and presentment warranties. 

So what happens if an altered check is deposited at a credit union, the credit union transfers the check for consideration in the check collection process, and the paying bank comes after the credit union for a breach of warranty? Assuming that the paying bank failed to return the check by the midnight deadline, the paying bank might be limited to seeking recourse for a breach of warranty under Articles 3 and 4 of the UCC.

As discussed in the Compliance Monitor article, there are two applicable warranties commonly associated with these types of breach scenarios: the transfer warranties and presentment warranties. Each time a check is transferred in exchange for consideration, the transferor warrants that

• The warrantor is a person entitled to enforce the instrument (i.e., there are no unauthorized or missing indorsements);
• All signatures on the check are authentic and authorized;
• The check has not been altered (meaning unauthorized changes were made);
• The check is not subject to a defense or claim in recoupment of any party which can be asserted against the warrantor;
• The warrantor has no knowledge of any insolvency proceeding (e.g., bankruptcy) commenced with respect to the person making the check or the financial institution the check is drawn on; and
• For a remotely-created consumer check, that the accountholder authorized the issuance and the amount of the check.  See, UCC §§ 3-416(a) and 4-207(a).

When a check is presented for payment, the presenting bank and the earlier transferors warrant that:

• The warrantor is or was a person entitled to enforce the check;
• The check has not been altered;
• The warrantor has no knowledge that the drawer's signature is forged; and
• For a remotely-created consumer check, that the accountholder authorized the issuance and the amount of the check. See, UCC §§ 3-417(a) and 4-208(a).

So if a check was altered, there is a potential breach of the transfer and presentment warranties by the warrantor. And the paying bank could potentially recover damages for the breach of the warranties. See, UCC §§ 3-416(b); 3-417(c); 4-207(c); 4-208(a). But the UCC expressly discharges a warrantor's liability in certain circumstances:

 The warranties stated in subsection (a) cannot be disclaimed with respect to checks. Unless notice of a claim for breach of warranty is given to the warrantor within 30 days after the claimant has reason to know of the breach and the identity of the warrantor, the warrantor is discharged to the extent of any loss caused by the delay in giving notice of the claim. See, UCC §§ 3-416(c); 3-417(e); 4-207(d); 4-208(e). 

There are two limitations here set forth in the statutory language.  First, the 30 days does not being to run until the claimant - the paying bank in our example - has reason to know of the breach and the identity of the warrantor.  Second,  even if the notice fell outside of the 30 day window, the statute suggests that a warrantor is only discharged to the extent of any loss caused by the delay in giving notice of the claim. So the 30 days referenced in the statutory language may not be helpful to the extent that any delay in delivering the notice of the breach of warranty did not cause a loss. While the 30 day window can provide some cover for a potential breach of warranty claim, it does not automatically discharge all loss. 

As with all matters related to the UCC, credit unions may wish to consult with local counsel due to the fact that not all states adopt the model version of the UCC. Local counsel can help identify certain provisions that are unique to particular states.

On an unrelated note, the CFPB has extended the temporary threshold for reporting open-end lines of credit under HMDA for two years. So for 2020 and 2021, financial institutions that originate fewer than 500 open-end lines of credit in either of the two preceding calendar years will not need to collect and report data for open-end lines of credit. This is something that NAFCU has been advocating for, and the CFPB indicated that the thresholds will be the subject of a separate final rule in 2020.

Programming Note.  NAFCU is closing at noon today in honor of Columbus Day weekend.  There will be no Monday blog, but we will be back to blogging on Wednesday, October 16th.